A provision of the SECURE 2.0 Act of 2022, scheduled to become effective in 2024, is riddled with uncertainty as plan sponsors wrestle with vague language and administrative headaches, and industry lobbying groups plead with the IRS for a delay.
The law change, in Section 603 of SECURE 2.0, says that highly paid 401(k), 403(b) and governmental 457(b) participants who want to make age 50 and over catch-up contributions will be required to make them on a Roth basis. Since 2002, Congress has allowed older plan participants to make catch-up contributions on top of regular pre-tax and Roth elective deferrals. In 2023, extra contributions of up to $7,500 can be made to supplement $22,500 of regular deferrals.
Currently, catch-up contributions are automatically made to pre-tax accounts unless the plan allows Roth contributions, in which case eligible employees can choose between pre-tax or Roth. Starting next year, participants whose wages from the plan sponsor in the preceding calendar year exceed $145,000 (as indexed), must have the catch-ups sent to the Roth account.
Example 1: Amy, age 55, and Audrey, age 56, work for Acme Architects, which offers a 401(k) plan. Amy, who was paid $250,000 in wages from the company in 2023, must make any catch-up contributions for 2024 to the plan as Roth contributions. Audrey, who received $100,000 in wages from Acme in 2023, is not required to make her catch-up contributions as Roth contributions but can choose to do so (if the plan allows).
A Revenue-Hungry Congress Forces A Roth Benefit—And That’s A Good Thing!
Section 603 is one of several Roth provisions in SECURE 2.0, and the fact that it is grouped within a part of SECURE 2.0 titled “Revenue Provisions” is a tip-off that it’s designed to raise revenue to pay for other changes in the legislation. Of the various Roth provisions, this is the only mandatory one.
This required Roth treatment is not necessarily bad. Even though Roth contributions are made on after-tax pay, they can be distributed tax free at any time. And, earnings on the contributions can also come out tax free if certain conditions are met (generally, the participant must be 59½ or older and a five-year holding period must be satisfied). The Roth requirement may simply force high-earning employees into an outcome that makes more sense for them anyhow.
The only lost tax benefit in forcing a Roth 401(k) contribution is that the employee will not receive a deduction (exclusion from wage income) for making the catch-up contribution to the pre-tax 401(k). But that is only a temporary benefit. This “deduction” is really just a loan you are taking from the government which will eventually have to be paid back at retirement. The larger the pre-tax funds grow, the higher the tax bill will be.
Drafting Glitch
Since SECURE 2.0 was rushed through at the very last minute, it’s not surprising that there are several drafting glitches. One of them involves the mandatory Roth catch-up rule. In adding that change to the tax code, Congress inadvertently deleted a part of the code that effectively bars any employee (higher-income or not) from making any catch-up contributions (pre-tax or Roth) starting in 2024. On May 23, 2023, several high-ranking members of Congress sent a letter to the IRS saying they intend to introduce a bipartisan “technical corrections” bill that would fix this mistake (and the others). The letter did not indicate when the bill would be introduced and, as of press time, it has not been.
Unanswered Questions
The language of Section 603 leaves a bunch of questions unanswered. The most important is: What if the plan doesn’t already allow participants to make elective deferrals on a Roth basis? After all, nothing in the law currently requires a plan to offer the Roth option. Here’s where it gets tricky. SECURE 2.0 seems to say that a plan that doesn’t comply with the mandatory Roth requirement can’t offer catch-up contributions to anyone starting next year. Did Congress really intend that?
Mandatory Roth catch-ups only apply to employees who have wages above a certain dollar amount in the previous year. SECURE 2.0 specifically uses the term “wages.” But many self-employed business owners don’t have wages; instead, they have business income. So, older plan participants with business income apparently aren’t covered by the new law. This would mean that age 50-or-older business owners with more than $145,000 of income in 2023 can still make pre-tax catch-ups to their plan in 2024.
SECURE 2.0 also says that prior-year wages must be with the employer sponsoring the plan. This look-back rule apparently means that new employees—no matter how well paid—will get a free pass from the mandatory Roth requirement in their first year of employment (because those employees have no wages the previous year from the new company). And, in the right situation, highly paid employees also will not have to make catch-up contributions on a Roth basis in their second year of employment.
Example 2: Barry, age 51, takes a new job with Beta Company on September 1, 2024. He earned $2.0 million of wages with Alpha Company (his prior employer) in 2023 and earns $125,000 with Beta between September 1, 2024, and December 31, 2024. Barry’s catch-up contributions to Beta’s 401(k) plan in 2024 don’t have to be made as Roth contributions because he didn’t have any wages with Beta in 2023. He’s also not required to make his 2025 catch-ups on a Roth basis because his 2024 Beta wages are under the 2024 threshold ($145,000, indexed for inflation).
Appeals For Delay
Given all this uncertainty, it’s no wonder there’s a big push to get the IRS to delay the effective date of the new law beyond January 1, 2024. Many employers that don’t already offer Roth plan contributions say they don’t want to shut down catch-up contributions for everyone, but simply lack the time to add Roth accounts by January 1.
This is especially burdensome for state and local governmental employers where adding a Roth may require action by the legislative body or negotiations with unions. And even many companies that already offer Roth contributions say that adjusting their systems by the end of the year to accommodate the new rule will be next to impossible.
On July 19, the most recent of several letters requesting a postponement was sent to the IRS. It was signed by a mix of groups: lobbyists, including American Benefits Council, American Retirement Association, The ERISA Industry Committee and U.S. Chamber of Commerce; private employers, including IBM, UPS and Xerox; governmental plans, including Teachers' Retirement System of the City of New York; and plan recordkeepers, including Alight Solutions, Empower and Fidelity.
In the face of this powerful opposition, it’s a good bet the IRS will agree to a delay.
Ed Slott, CPA, is a recognized retirement tax expert and author of many retirement-focused books. For more information on Ed Slott, Ed Slott’s 2-Day IRA Workshop and Ed Slott’s Elite IRA Advisor Group, please visit www.IRAhelp.com.